Securities & Exchange Commission Rule 10b-5 (17 C.F.R. section 240.10b-5) is the legal foundation for private securities fraud class action lawsuits and SEC insider trading actions. The regulation, in full:
Employment of manipulative and deceptive devices.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
Most -- if not, in reality, all -- private securities fraud class action lawsuits are brought under subsection (b) of the rule, and allege that a corporation, through its officers and/or directors, made false statements to investors in order to induce the investors to purchase the corporation's stock at artificially inflated prices.
Rule 10b-5 was promulgated by the SEC pursuant to Section 10(b) of the Securities & Exchange Act of 1934, 15 U.S.C. section 78j(b). That statutory section, in full:
Manipulative and deceptive devices.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange -
To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
The Rule has been the focus of considerable judicial, and recently Congressional, attention. Practically every phrase in the Rule is subject to judicial interpretation and intense debate among practitioners.
On a related topic, effective October 23, 2000, the SEC issued Rule 10b5-1 (note the moved dash), which purports to define what constitutes illegal insider trading for the purposes of SEC enforcement actions.